CFTC Unveils Blueprint for Swaps Rules Reboot

President Trump has declared the Dodd-Frank Act a “disaster” and has promised to drastically overhaul it. But the Trump-nominated CFTC Chairman, J. Christopher Giancarlo, has so far shown a more measured approach to Dodd-Frank reform.

During a discussion at the International Swaps and Derivatives Association’s Annual General Meeting on April 26th, Giancarlo announced the release of a new white paper, Swaps Regulation Version 2.0: An Assessment of the Current Implementation of Reform and Proposals for Next Steps. Noting that the Chairman “has long been a public supporter of the swaps market reforms passed by the U.S. Congress in Title VII of the Dodd-Frank Act,” the paper, which Giancarlo co-authored with CFTC Chief Economist Bruce Tuckman, lays blame for problems in the swaps markets not with the Dodd-Frank Act’s mandated reforms, but rather with the CFTC’s implementation of those reforms. Similarly, the Wall Street Journal observed that the white paper represents “an update, rather than a repudiation, of Dodd-Frank,” with Giancarlo and Tuckman emphasizing they are looking for ways to “optimize” the existing swaps rules “to strike a balance between systemic safety and stability and market vibrancy and economic growth.”

Despite the authors’ criticism of the CFTC’s implementation of Dodd-Frank swaps reforms, the white paper determined that the agency’s approach to the Dodd-Frank’s mandate on swaps clearing — which it called “the most far-reaching and consequential of the swaps reforms” — has been “highly successful,” noting the substantial increase in the volume of swaps transactions cleared by central counterparties (“CCPs”). In other areas, particularly with respect to swaps reporting and swaps execution rules, the white paper concluded that the CFTC’s implementation was “flawed and ineffective,” maintaining that the rules adopted by the CFTC for swaps execution “missed the mark set by Congress” in the Dodd-Frank Act. Giancarlo and Tuckman suggest that the CFTC’s approach to the swaps execution rules, which restricted swaps execution to two methodologies, has resulted in the global fragmentation of swaps markets, increased market liquidity risk, and the transfer of swaps liquidity formation and price discovery away from swap execution facility (“SEF”) platforms.

To address the perceived shortcomings in the swaps execution rules, the paper proposes eliminating the current restriction on the methods of execution by allowing SEFs to offer any method of execution for swaps subject to the Trade Execution Requirement. According to The Wall Street Journal, Giancarlo told conference attendees that he plans to take action soon to advance a specific proposal to revise the swaps execution rules, which is expected to be released in July.

While Giancarlo hesitated to promise immediate action on other recommendations, the paper does set out ideas that could form the basis of future rulemaking or policy proposals. For instance, The Wall Street Journal notes that in the paper Giancarlo and Tuckman make the case for the use of Dodd-Frank-mandated orderly liquidation funds to ensure continuity of clearing services, should the failure of a CCP threaten the stability of the financial system. The embrace of Dodd-Frank’s orderly liquidation procedures comes on the heels of a similar recommendation by the Treasury Department for banking regulators to retain the Orderly Liquidation Authority for the resolution of complex financial institutions, which concluded that the much-maligned provision of Dodd-Frank was necessary to ensure financial stability. The authors call for the CFTC and the FDIC to work together on resolution planning for CCPs. Finally, maintaining that the current regime overestimates the risks for swaps, they call for regulators to rely more heavily on the internal risk models used by banks and their swap affiliates, and that current bank capital requirements be adjusted accordingly. These recommended changes would require action by international and other U.S. regulators.

Giancarlo has long advocated for changes to the CFTC’s swap execution rules, and the white paper reflects his commitment to prioritizing swaps rule reform in his role as CFTC chairman. However, the agency’s ability to implement his plan faces numerous hurdles. As Bloomberg recently pointed out, the proposals, which “mark the biggest policy shift for the agency during the Trump administration,” face a long road to adoption, as they would have to undergo the CFTC’s lengthy rulemaking process, including a public notice and comment period. The Financial Times further notes that Giancarlo’s ability to see the proposed reforms to fruition may be hampered by the fact that his term expires next year.

Finally, at least one major hurdle comes from Giancarlo’s own Republican party and the President who nominated him. The push for deregulation combined with the realities of tax reform– the Congressional Budget Office estimated that government revenue will decrease by $1.3 trillion over the next decade—has left many federal agencies with the need to tighten their belts. Giancarlo has lamented the fact that the CFTC is “not properly funded” and was “astounded” to learn that instead of approving his request for an annual budget increase of $31.5 million, Congress instead recommended a $1 million cut. Ironically, then, the agency’s ability to reboot Dodd-Frank may be jeopardized by the very impulse that required it in the first place: the view that government is too big.